Growth is Dead: Part 5-Innovation?

Now well on our way into the Growth is Dead series, it’s only fair to offer up what we hope are some constructive ideas on how to deal with this phenomenon going forward.

But first, a quick recap of some of the things we’ve touched upon:

From more or less 1980 until approximately September 15, 2008, the industry of BigLaw enjoyed an unprecedented run of growth in revenue, profitability, and headcount, with compound annual growth rates in the middle to high single digits for virtually that entire period, with only the occasional hiccup.

This is almost unheard of in modern economies, and the Rothschilds could tell you a thing or two about the impact of that level of CAGR for that period of time (hint: it’s how they made their fortune).

The only other industries I can think of that rival anything like that kind of track record are nascent ones – say automobiles at the turn of the last century. (We’re not a nascent industry.)

Everything changed with the Great Reset.

Clients, who had always had power but might not have known or exercised it, realized they did and they could. This will not change back.

Pricing pressure is here to stay.

The traditional bimodal career path within law firms, associate and partner, has multiplied into a large, and growing, variety of ways to work for BigLaw:

partner-track associates

non-partner-track associates

staff, temporary, and contract lawyers

flex-time, work-at-home, and sabbatical-leave tracks

“of counsel” and non-equity partner positions

partners or former partners now serving full-time in management roles

The BigLaw industry suffers from excess capacity on several levels, including

a surfeit of JD graduates being churned out by US law schools

too-high levels of leverage among traditional associate ranks

overpopulated ranks of non-equity partners

underperforming equity partners

And excess capacity at the most fundamental level, I fear, means too many undifferentiated firms chasing too much of the same types of business, and tempted to engage in short-sighted, self-defeating pricing to keep revenue flowing.

Enough diagnosis. How about some prescription?

If you could take one and only one concept away from this series, it’s this:

(1) Other industries, including professional service industries,
have been dealing with all these challenges and more for a long time.

(2) We could learn a few things from them.

As Exhibit A I’ve chosen Procter & Gamble under the leadership of its CEO A. G. Lafley.

What does P&G sell? Products such as Crest, Tide, and Pampers. What’s their intrinsic growth rate? Same as population growth. Not only that, but by the time of Lafley’s ascension, P&G had become a $70-billion/year enterprise. Even 4-6% annual growth would require building a brand-new $4-billion/year business every single year. What could you possibly do to accomplish this?

Lafley bet on innovation.

Pause to understand how the market landscape confronting Lafley at P&G in 2000 resembled the landscape that I believe is confronting BigLaw today:

P&G’s “intrinsic” growth rate more or less tracked population growth;

Our “intrinsic” growth rate more or less tracks global GDP growth, with perhaps a slight bonus for increasing cross-border transaction volume and the steady march of regulation’s complexity quotient.

Editor’s note: Procter & Gamble has operated one of the greatest research and development operations in corporate history. But as the company grew to a $70 billion enterprise, the global innovation model it devised in the 1980s was not up to the task. CEO A. G. Lafley decided to broaden the horizon by looking at external sources for innovation. P&G’s new strategy, connect and develop, uses technology and networks to seek out new ideas for future products. “Connect and develop will become the dominant innovation model in the twenty-first century,” according to the authors, both P&G executives. “For most companies, the alternative invent-it-ourselves model is a sure path to diminishing returns.”

And here’s what Lafley had to say about where innovation is occurring in today’s economy. Not in the big institutions:

We discovered that important innovation was increasingly being done at small and midsize entrepreneurial companies [including] access to talent markets throughout the world. And a few forward-looking companies like IBM and Eli Lilly were beginning to experiment with the new concept of open innovation, leveraging one another’s (even competitors’) innovation assets—products, intellectual property, and people.

As was the case for P&G in 2000, R&D productivity at most mature, innovation-based companies today is flat while innovation costs are climbing faster than top-line growth.

We knew that most of P&G’s best innovations had come from connecting ideas across internal businesses. And after studying the performance of a small number of products we’d acquired beyond our own labs, we knew that external connections could produce highly profitable innovations, too. Betting that these connections were the key to future growth, Lafley made it our goal to acquire 50 percent of our innovations outside the company. The strategy wasn’t to replace the capabilities of our 7,500 researchers and support staff, but to better leverage them. Half of our new products, Lafley said, would come from our own labs, and half would come through them.

It was, and still is, a radical idea. As we studied outside sources of innovation, we estimated that for every P&G researcher there were 200 scientists or engineers elsewhere in the world who were just as good—a total of perhaps 1.5 million people whose talents we could potentially use. But tapping into the creative thinking of inventors and others on the outside would require massive operational changes. We needed to move the company’s attitude from resistance to innovations “not invented here” to enthusiasm for those “proudly found elsewhere.” And we needed to change how we defined, and perceived, our R&D organization—from 7,500 people inside to 7,500 plus 1.5 million outside, with a permeable boundary between them.

The proof was in the pudding, and the model worked: From 2000 to 2006, the proportion of new products on the market that included one or more elements originating outside P&G went from 15% to 35%, an increase of 133%, and the number of P&G brands generating a billion dollars or more in annual revenue was up to 22.

Essentially, what Lafley led P&G to do was to introduce completely new ways of doing old things (Swiffer) or slightly different ways of doing old things that consumers perceive as better, hence more valuable (how many iterations of Crest are on the market now compared to a dozen years ago?).

In other words, faced with the implacable obstacle of the rate of population growth as a presumed ceiling on P&G’s growth rate, Lafley routed around it and chose to answer a question not posed by the premise.

I challenge you to name a single law firm thinking in that fashion. And I pose the immediate follow-up: Why not?

Finally, one last challenge in the form of a few lessons, from Lafley: In May 2008 he was interviewed at Harvard Business School (the link includes a video) and the moderator summarized his takeaway as follows. I’ve added my thoughts in brackets following each:

1. In an age of disruption, growth is getting increasingly difficult. [That’s precisely the point.]

2. Companies need to take the long view. Lafley said he finds it hard to watch CNBC for more than 7 minutes because the focus is so short term. [Thank goodness we don’t have CNBC; may I point out we have now had PPP figures published for 25 years.]

3. The customer needs to be the center of the innovation equation. When Lafley took over as CEO in 2000, he said he saw too many managers on their cellphones, or buried in spreadsheets, in essence “showing customers their behind.” [Ring a bell? Anyone?]

4. Experimentation is key. Lafley talked about the value of giving customers even crude prototypes to test an idea. He also described how different parts of his organization approach innovation differently, and that’s a good thing. [Not directly applicable to us, perhaps, but when was the last time your firm showed a client a “crude prototype” of something you were thinking of doing? Thought not.]

5. Complex organizations need to simplify to successfully innovate. Lafley said he seeks Sesame Street simplicity. [When was the last time involving dozens of lawyers reduced complexity?]

6. The CEO has to be the “Chief External Officer” to manage external pressure and the “Chief Innovation Officer” to push the innovation agenda forward. [Neither of which roles comes naturally to most lawyers.]

To repeat, I dwelt on P&G under Lafley because they faced a market landscape with intrinsically limited growth, as do we, and he approached it in ways we would never dream of, including inviting ideas from outside the firm and developing totally new products in segments thought to be stagnant.

The American Lawyer just published “The 2012 Global 100: A World of Change,” which opens as follows:

The legal sector used to be such a nice, calm place to do business. Partners and clients would occasionally come and go. The odd practice would falter, while a few firms made slightly more money than everyone else. But the market historically lived up to its reputation as a bastion of sleepy conservatism and resilience. Then came the financial crisis, which forced the legal elite to adapt to the most turbulent market conditions for a generation.

As firms tussle for position in this new world order, the pronounced uptick in law firm merger activity has transformed our Global 100 rankings. New giants are emerging to dominate our charts, thanks in part to the increasing use of looser organizational structures that have facilitated these combinations.

The net result of all this change is that The Global 100 has become more top-heavy. The upper echelons of the international legal market, as measured by revenue, are becoming increasingly dominated by a smaller number of larger firms. And the gap is widening.

LegalWeekreported at the end of September that the UK’s top 20 law firms saw 439 partners leave in 2011—2012, “as firms continue to actively manage their partnerships.”

In particular, the Magic Circle posted partner departure rates of 2—4%, partly reflecting the “increased mobility of partners,” but also “the trend for de-equitisations.”

Lest you think this is a post-Great Recession fad, here’s what a leader of one, willing to be quoted on the record, had to say (emphasis mine):

A&O managing partner Wim Dejonghe said: “Greater financial and operational discipline is definitely necessary in order to remain competitive in a low-growth environment.

“For us, it’s been a question of balancing the need for growth in the global network with continued focus on good housekeeping.

“The same challenges exist for all our competitors and everyone has to make a choice about where that balance lies and what’s right for their business – it’s just a reality of the market we live in today.”

On this side of the pond (although all these firms are global in the most profound sense), K&L Gates Chairman and CEO Peter Kalis was interviewed on the occasion of being re-elected to another five year term, and among other things had this to say (emphasis mine):

Kalis says his hardest day-to-day challenge is constructing a “modern business enterprise suitable for the 21st century.” He likens the process of growing the K&L Gates brand, cultivating cutting-edge information technology, and managing the myriad other aspects of the firm’s finances to “building a bridge in wartime.“

Both Dejonghe and Kalis, at the top of two of the largest law firms in the world, are telling us we’re subject to the discipline of the market “in a low-growth environment,” and that we must be 21st-Century business enterprises or…perish.

I dwelt on A.J. Lafley and P&G earlier because they confronted these Darwinian pressures of the marketplace a dozen years ago, and responded in an enormously creative, not to mention successful, fashion. Will we have the imagination, the applied intellectual horsepower, and most critically of all the unswerving resolve, to do the same?

I wish I could tell you I have confidence in us all to do that.

I don’t, and in the final installment in this series I’ll try to explain why.